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The Vanishing LATA: Pricing Chasms and Clashing Markets for Toll Service

Fortnightly Magazine - July 15 1996

when we studied the effects on U S WEST and AT&T if the residential toll disparity disappeared, and one or the other carrier's toll prices dictated the market and determined the new price equilibrium, without accounting for elasticities or other feedback effects.

The benchmark case displayed in Table 2 estimates the total residential toll revenues collected by U S WEST and AT&T, respectively, in 1995. The combined benchmark revenues of $28 million are assumed to include intrastate residential MTS sales in all mileage bands for three time periods (day, evening, and night/weekend).

In this example, if prices at U S WEST increased to equal AT&T's and nothing else changed, the figure for combined revenues would rise to $34 million. Conversely, if AT&T lowered its prices to the levels for U S WEST and nothing else changed, the combined annual revenue figure would decline to $25 million

These results permit one to estimate the hypothetical cost to U S WEST of implementing 1+ intraLATA equal access. If AT&T captured the entire U S WEST residential market, U S WEST could lose $17 million (leaving aside any offsetting increases in carrier access-charge revenues that would substantially diminish this revenue loss).

Thus, we could conclude that total revenues do not vary significantly in relation to price changes. If AT&T's prices declined to equal those for U S WEST, AT&T would lose about $3 million in revenues, and U S WEST would enjoy no benefits. However, because these conclusions do not reflect market realities, we must include demand elasticities and carrier access charge (CAC) impacts in our analysis.

Complex Case: Consider Elasticities

To inject market realities (again, see sidebar, "Model and Parameters"), we conducted a second-stage analysis to consider how price elasticities and other "feedback" effects might influence the eventual equilibrium price and carrier revenues if U S WEST and AT&T modified prices in the residential toll market to eliminate price disparities. We show the results in Table 3.

Our second-stage analysis uses two alternative own-price elasticities of demand: -0.5 (low) and -2.0 (high). These two values likely define the boundaries of the unknown actual demand elasticity.4 Given the looming market changes, we find the often-used demand elasticity range of -.5 to -1.0 on the low side.

Elasticities take many forms, two of which are "own" and "cross." These two elasticities are easily understood in the context of energy markets; they are less intuitive with telecommunications.

For example, if the price of natural gas falls by 50 percent, one normally expects consumption of natural gas to increase as customers luxuriate in warmer homes. This behavioral response is captured in own-price elasticities: As the absolute price of gas declines, the demand for gas increases. Yet other customers may switch from electric space heat to natural gas. This behavioral response is captured in cross-price elasticities: As the price of gas declines relative to electric prices, the demand for natural gas increases as it is substituted for electricity.

While electricity and natural gas can be considered substitute goods, intra- and interLATA toll services may display both substitute and complementary